3 things to keep in mind
Ahead of our “Let’s Talk About” series, we bring to you 3 things that all start-ups, founders and owners should think about when considering implementing an employee incentive program (aka employee share scheme, employee share optionscheme).*
1. Securities law: the Financial Markets Conduct Act 2013 (FMC Act)
New Zealand's securities law is principally governed by the FMC Act.
In employee share schemes, and in capital raising generally, founders need to be aware of the restrictions on offering shares in the FMC Act. The general rule is that unless an exemption applies, the full disclosure requirements of the FMC Act (think prospectus/product disclosure statements, potentially $100k+ of professional fees) apply to an offer of shares (securities).
For this reason, start-ups and founders typically rely on the exemption for employee share purchase schemes in the FMC Act.
One of the key requirements to qualify for this exemption is that no more than 10% of the total number of a company's shares can be offered under a qualifying scheme in a 12-month period. The scheme also can’t be set up for the main purpose of capital raising.
Key takeaway: keep in mind the magic number 10%
2. Different ways to structure your scheme
There are different ways to structure your scheme, such as:
- Direct shareholding (employees/contractors all hold shares in their own names)
- Trustee scheme (trustee company holds all of the scheme shares on trust for employees/contractors who have a beneficial interest)
- Options scheme (employees/contractors have an option to purchase shares in future)
- Phantom share scheme (no shares or options are issued, but there is a right for employees/contractors to receive cash in certain situations)
Thought should be given to the reasons behind setting up your scheme, e.g. to attract, motivate and retain key employees, to change the way employees think and behave, to increase remuneration or reward performance, or to put in place a succession plan. Also consider whether or not you want employees to have a voice and/ or become shareholders in future. These reasons (along with tax) will probably dictate which structure you go for.
Key takeaway: Think about whether you want employees to have the same rights as existing shareholders.
3. What happens when an employee leaves?
A key point for founders to consider is what happens to the employee's participation in the scheme if they leave. There are many ways to approach this.
For options schemes some have ex-employees lose the right to participate altogether. In others, participants can exercise the option to acquire shares when they leave but they then must immediately be sold. Another alternative is to allow people to stay on if they have already become shareholders and to exercise any remaining options within a set period.
Where employees are shareholders, you can address this by 'good leaver' and 'bad leaver' provisions in a Shareholders Agreement or side letter, which can setout the consequence on the employee's entitlement depending on the circumstances under which they leave the company (e.g. a redundancy or retirement situation may be a ‘good leaver’ allowing an employee to retain shares or sell their shares at market value).
Key takeaway: think about what you would want to happen if an employee in the scheme leaves
*In the US the term ESOP (employee stock option program) is commonly used.